The Economic Effects of Unemployment Compensation

Abstract

This paper has analyzed the experience rating feature of an unemployment compensation system. The question of how the costs of maintaining the unemployed are allocated was addressed. A review of the current literature found a lack of research on the impact of the UI tax structure on the economy. The problem of cost allocation was seen to lie in determining which output prices reflect these costs and thus determine how the market allocates resources. The model developed involves three steps. The first two of these; which are the perfectly competitive solution to compensating the unemployed and the solution imposed by a perfectly experience rated UI system, respectively; developed benchmarks to be compared to the third model, that of the UI system as it actually is. The primary conclusion of the model is that imperfect experience rating of the UI tax causes an interfirm subsidization of seasonal unemployment with resulting non-optimal allocation of resources among firms. The secondary, and empirically testable conclusion, is that the degree of experience rating of the UI tax is inversely related to a firm's layoff rate. The available data was tested using ordinary least squares methods. The regression results yielded inconclusive evidence to support the hypothesized relationship between tax rate ranges and layoff rates.